Friday, December 2, 2016

A 21st century U.S. trade dollar

"America's only unwanted, unhonoured coin."

- John Willem on the silver trade dollar.

The inspiration for this post comes from the old trade dollar, a U.S. silver coin that was minted in the 1870s and 1880s for the sole purpose of circulating in China. Taking the trade dollar as a model, I'm going to discuss the idea of converting the U.S. $100 bill into a trade bill; i.e. to limit it to foreign and not domestic usage.

Why bother modifying the $100 in this way? While not entirely convinced, I do lean towards Ken Rogoff's idea of getting rid of high denomination banknotes like the Canadian $100, the Swiss 1000 franc, and the Europe's €500. These bills are used primarily by criminals and tax evaders; their removal will make these activities more costly. The public's licit demand for a private means of payment can be met by low denomination notes, as can the necessity for a convenient physical payments medium on the part of the unbanked.

But as I wrote here, the Federal Reserve's $100 is categorically different from the above banknotes. The dollar plays a special role as the world's backup medium of exchange and unit of account. Abolish the $100 and not only will those dollarized countries already using U.S. banknotes (many of them poor) be hurt, but so will the desperate citizens of foreign countries who might try to flee to the dollar in the future due to the awful monetary policies of their leaders, usually dictators.*

By converting the $100 into a trade bill, everyone can have their cake and eat it too. Like the old silver trade dollar, the $100 trade bill will be barred from playing a role in the U.S. economy, thus doing damage to the domestic underground economy. But it will be free to be used in places like Venezuela which, thanks to misgovernance, are in urgent need of a better monetary standard.

To help determine the structure of a modern $100 trade bill, let's explore the design of the 19th century silver trade dollar. China had a long history of using silver as money, and as trade with the west grew the Spanish silver dollar—minted in Mexico—had become quite popular with Chinese merchants. U.S. traders were penalized as they had to acquire Mexican dollars at a premium to the coin's intrinsic silver value in order to do business with China. Enter the trade dollar. The idea was to introduce a U.S. equivalent to the Mexican dollar in order to help out U.S. merchants, who would no longer have to pay a premium. The trade dollar would also provide domestic silver producers, an important political constituency, with an outlet for their production.

While U.S. legislators liked the idea of having U.S. silver coins circulate overseas, they did not want the trade dollar to be used in the U.S. After all, the U.S. was in the midst of giving up the old bimetallic standard (silver and gold) in favour of a gold standard, and a new silver coin might interfere with this process.

Thus, we arrive at the Coinage Act of 1873, which simultaneously took the U.S. off of silver (by ending the free coinage of silver) while also introducing the trade dollar. To ensure that the trade dollar would not be "made a part of or be in any way confounded with our monetary system," its legal tender status was limited to $5 i.e. no domestic debt could be extinguished with more than $5 in trade dollars (for a review of legal tender, go here). To further hurt its domestic usefulness, this legal tender status would be completely revoked in 1876.

While the trade dollar was well-received in China (most of them were chopped), it wasn't entirely successful in staying out of domestic U.S. circulation. According to Garnett, of the $35.9 million in trade dollars coined, $29.4 million were exported. Of this amount, $2.1 million returned to the U.S., joining the $6.6 million that had never left the country.

It's important to understand why trade dollars sometimes stayed in the U.S.—after all, the idea of a trade bill simply won't work if $100 notes continue circulating in the U.S. There seems to be two reasons for this. From 1873 until 1876, trade coins still had a limited value as legal tender. At first, this wasn't an issue. Since the intrinsic value of the coins' silver content exceeded their official legal tender value, it made little sense for Americans to use them to settle local debts—debtors would be effectively overpaying if they did so. However, as silver prices fell through the 1870s the official legal tender value of trade dollars began to exceed their intrinsic value, at which point it was profitable for debtors to pay off their bills in overvalued silver trade dollars. This would have diverted trade dollars from China in order to meet local demand.

Secondly, speculators began to buy trade dollars in China and bring them back home on the expectation that the U.S. government would eventually redeem them at their original value of $1, even as they traded at around 80 cents on the dollar. This belief was eventually realized in 1887 when Congress compelled the government to redeem all trade dollars at par.

So with these design flaws in mind, let's design our $100 trade bill. To begin with, on January 1, 2017 the U.S. government will announce its intention to rescind the legal tender status of $100 bills. That means the $100 can no longer be used by a debtor to discharge any U.S. debt. Legal tender status must be entirely rescinded to avoid the mistakes of the trade dollar.

Next, the Federal Reserve announces that after a certain date (say January 1, 2019), all domestic deposits and withdrawals of $100 notes will be illegal. Until then, the public enjoys a two-year window for bringing bills into banks or Federal Reserve branches for conversion into $20 bills or deposits. To prevent local hoarding of $100 bills, the domestic closure of the "$100 window" must be perceived to be permanent. Remember that trade dollar inconvertibility was perceived to be temporary, thus encouraging domestic demand. Likewise, if they anticipate a re-opening of the "$100 window," Americans will simply keep their $100s at home.

Banning local redemption will likely force all local retailers, wholesalers, and other businesses to stop accepting $100 bills. A retailer like Walmart that receives a $100 bill during the course of business will have to ship it overseas to be spent or deposited, and that would be quite expensive. Likewise, licit person-to-person exchanges of $100s will be crimped. Lacking domestic acceptance by banks and retailers, the $100 will have no liquidity, and regular people will no longer be willing to accept them.

For these same reasons, illicit domestic usage of $100s will suffer. Since no legitimate businesses will accept them, criminals won't be able to spend $100 notes into the local economy. To launder $100 bills, it will now be necessary to send them overseas for deposit into foreign banks. This will impose significant handling costs on money launderers, especially if the government institutes laws that limit large cash exports. These handling costs will probably be high enough to force domestic illegal currency users to migrate to $20 bills as their preferred medium.

While domestic usage of $100s will rapidly decline, foreign-based banks will be completely free to allow deposits and withdrawals of $100 banknotes, much as they do now. To get $100 notes shipped from the U.S., foreign banks will have to put in orders with a Federal Reserve bank (they tend to prefer the New York Fed's cash office and, in the West, the San Francisco Fed's Los Angeles cash office). To redeposit $100 bills, they will have to send them by plane back to New York.

This setup should be sufficient to flush most $100 bills out of domestic circulation, forcing U.S.-based criminals and tax evaders to fall back on less convenient $20s. And just as the trade dollar successfully met Chinese demand for silver money, the $100 trade bill will meet Panamanian, Zimbabwean, and other foreign demand for U.S. high denomination cash.

*Rogoff believes that a policy of removing high denomination notes should only be enacted by developed nations. But since so many undeveloped nations use the dollar, Rogoff is being inconsistent in calling for an end to the $100.

To read more about U.S. trade dollars, here are some good sources:A Trade Dollar Song and Chorus, 1883 (link)Collecting Trade Dollars (link)The History of the Trade Dollar (link)The British (link), Japanese (link), and French (link) also issued trade dollars

Milton Friedman wrote an excellent account of the switch from bimetallism to the gold standard (pdf).

5 comments:

JP, in light of India, would you tell us how you account for the economic costs, inefficiencies, and damages (and who bears them) of your various demonetization schemes?

Or is any level of economic disruption necessary and bearable in pursuit of a cashless economy? How much should we alter society to chase after criminals and tax evaders?

Where is your empirical evidence that eliminating currency is economically value-added? Is it even possible that eliminate-large-bill schemes are value- and efficiency- destroying? You don't seem to know either way.

What is so special about trade, anyway? Why not have education currency, healthcare currency, food currency. Call them vouchers or coupons. The government could elastically supply healthcare vouchers, for instance, in response to demand.

So why have a single domestic currency at all? Sure, there *might* be efficiency gains to a common currency, but I have a strong feeling that if we just separate currencies by usage, we would really stick it to those criminals and tax evaders!

"JP, in light of India, would you tell us how you account for the economic costs, inefficiencies, and damages (and who bears them) of your various demonetization schemes?"

The sort of demonetization I'm talking about would be very different from Modi's demonetization. The latter is an "aggressive" demonetization; the conversion of the $100 into a trade bill would require a passive demonetization, and only in the U.S., not internationally. By passive, I mean that it would offer a relatively large conversion window, say like how French francs were demonetized after the euro's introduction.

Passive denominations would not result in the sorts of things that we are seeing in India like lineups or unsold goods.

"Or is any level of economic disruption necessary and bearable in pursuit of a cashless economy?"

Certainly not. This post advocates removing the $100 bill, not a cashless economy.

"Where is your empirical evidence that eliminating currency is economically value-added? Is it even possible that eliminate-large-bill schemes are value- and efficiency- destroying? You don't seem to know either way"

Before I answer, have you read Ken Rogoff's book? If he can't get you to budge, I won't be able to either.

On the flip side, consider that it is your duty, JP, to make society fairer and more just. You are, I am sure unwittingly, advocating for trapping people in a corrupt system of bank surveillance and control alongside criminalizing actions where a victim cannot be found -- a panopticon of crimes against the state.

But no, you and Rogoff would use the awesome world-spanning economic power of monetary policy as law enforcement? That is, bluntly and simply, insane.

Besides, you know very well that eliminating $100 bills just shortens the timeline to Compubank. Dimes in the US used to be worth real money also. If all you and I have are $20s, they will be worth $10, then $5, and then around two bucks in 30 years. You've just entered cashless in real terms. Please don't quibble the point.

Consider going the other way! The Fed should introduce $500 bills. Free funding, free seigniorage, and a good deal for you and me to go Truck, Barter, and Exchange our way to prosperity.

"Besides, you know very well that eliminating $100 bills just shortens the timeline to Compubank. Dimes in the US used to be worth real money also. If all you and I have are $20s, they will be worth $10, then $5, and then around two bucks in 30 years. You've just entered cashless in real terms. Please don't quibble the point."

If consenting U.S. adults want to use the $100 locally, they are free to do so in a trade bill plan. Just because the $100 is not legal tender in the U.S. and unredeemable domestically doesn't mean that it will have been entirely eliminated. Will it be much rarer? Yes. Will it be tough to offload? Yes. You might have to go to Zimbabwe to spend your $100 bills.

Say that the highest domestic denomination becomes the $20. Once the price level has tripled, say thirty years later, re-introduce the $100 into domestic circulation. It makes sense to keep the highest denomination note at a low but constant purchasing power.

While removing the $100 bill's legal tender status makes sense, we should keep the $20 because we want a fixed price private payments option and an ungated payments product for use by the unbanked. No one wants a Compubank. If the $20 is not high enough for your tastes, use something like Zcash.